The Santa Rally 2023: Will It Happen?

As we enter the holiday period of 2023, investors are hopeful of a final upswing, a “Santa Rally”, to finish off the year. It has been a tumultuous eleven months so far, as markets have grappled with periods of recession and stagflation, hard landings and soft landings. The drama of a government shutdown and the horror of military conflict have been prevalent, whilst AI-mania has shone. These themes and narratives have swung through the course of 2023 with most participants initially expecting an economic slowdown, with even perhaps some 1970s-style stagflation. This was set in motion by central banks slamming on the brakes with continued policy tightening, which has been the most aggressive that most investors have seen in their lifetimes.  

However, the world’s biggest economies have coped admirably with higher interest rates, confounding many who expected recession and worse. “Good news is bad news” has been a familiar phrase as resilient growth in the US has sometimes meant the Fed continued raising rates, to the detriment of equities and especially the growth and tech sectors which have led the gains in US stock indices. Higher rates have historically hurt technology companies with high valuations that are based on future profits, as earnings years from now are worth less than today. 

Current Market Sentiment 

The market narrative has now shifted towards the prospect of a soft landing on signs that pandemic-related inflation is easing. What does this actually mean? This is a scenario where the Fed has raised interest rates just enough to slow the economy and cool inflation, but without doing too much policy tightening to cause a recession. However, the lingering concern of stagflation remains, as balancing economic growth and inflation continues to be a delicate challenge. 

Recent weaker than expected top tier US data, including cooler inflation and labour market figures, has cemented the idea that aggressive policy tightening is done. The focus is now on the timing and the potential pace of future rate cuts. Of course, we must acknowledge that central bankers cannot express the rate cut view in public as they would risk boosting risk sentiment to the point it loosens financial conditions too soon.  We have seen this recently, with Powell forced to dial back the dovish tone of his recent press conference after the November FOMC meeting.  

How Financial Markets Are Responding? 

Risk assets have reacted to these developments, plus a comforting US Treasury Department announcement about debt issuance, by sending government bond yields sharply lower. This has pushed the dollar down to near three-month lows, while global equity markets have bounced, with the benchmark, broad S&P 500 currently showing an 18% gain year-to-date ^[1]. A solid third quarter results season, with margin expansion and more positive earnings revisions than forecast, has underpinned support for stocks. Importantly, breadth in the market has expanded, with the small cap Russell 2000 participating in the rally.  

These bullish developments in stock markets have come about even though we are witnessing ongoing conflicts in both Ukraine and the Middle East. The latter has seen a short-term ceasefire but has the potential to escalate at any time. For now, markets are fairly sanguine over the outcome and comfortable that Iran and other actors will not inflame the situation. Indeed, the price of oil, a key barometer for investors, has turned lower recently with concerns over future demand weighing on crude.  

Will the Santa Rally Come in Play Again? 

The last month of the year has always brought with it a good feeling, and this has also historically been the case for stock markets too. Views are split as to the reasons why this boost occurs, but December is historically a good time of year for stock market bulls.  According to Dow Jones data, the benchmark S&P 500 index has ended higher in the final month of the year more often than any other month.  In fact, December has only ever been the worst month once, in 2018, when the blue-chip index fell 9.2%, beating the October decline of 6.9% two months before ^[2]. No month has a stronger average return than December.  

In fact, digging further into the finer details, markets increase in value specifically during the last week of December and into the first two trading days of the new year. Research shows that since 1950, this single seven-day period has produced a positive return for the S&P 500 78.9% of the time ^[3]. No other similar duration of trading sessions is more likely to be higher.  

US Stocks Rebound Amid Recession Concerns and Changing Consumer Trends 

The seasonal positivity at this time of the year now needs to account for US stocks which have rebounded strongly from their lows in October. The summer sell-off and losses have virtually been erased with four consecutive weeks of gains. Recession bells are ringing more loudly as the potential for a rollover in the US job markets continues. Recent comments from some of the US’ largest retailers have also grabbed the headlines recently, highlighting softening demand from the steadfast US consumer and could be a sign of things to come. Consumer activity represents nearly 70% of US GDP so markets are right to pay attention.  

But the widely followed Atlanta Fed GDPNow forecast for fourth quarter US GDP stands at 2%, which is certainly not recessionary ^[4]. Some economic data still remains resilient, and with positive seasonality and the extremely rare occurrence for the S&P 500 to close lower for two consecutive years, a Santa rally of some type could still occur as investors digest strong gains across the year.  

Conclusion 

In conclusion, despite the mixed economic signals and geopolitical tensions, the resilience of major economies and positive market trends hint at the possibility of a Santa Rally as 2023 draws to a close. Investors, buoyed by recent gains and hopeful of a favorable year-end, may see this period as a culmination of a year marked by challenges and recovery. 

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Reference 

1. “Do You Believe In The Santa Claus Rally? – LPL Research”. https://lplresearch.com/2021/12/22/do-you-believe-in-the-santa-claus-rally-2/ . Accessed 28 Nov 2023 

2. “2018 was the worst for stocks in 10 years – CNN Business”. https://edition.cnn.com/2018/12/31/investing/dow-stock-market-today/index.html . Accessed 28 Nov 2023 

3. “Do You Believe In The Santa Claus Rally? – LPL Research”. https://lplresearch.com/2021/12/22/do-you-believe-in-the-santa-claus-rally-2/ . Accessed 28 Nov 2023 

4. “GDPNow – Federal Reserve Bank of Atlanta”. https://www.atlantafed.org/cqer/research/gdpnow . Accessed 28 Nov 2023